CREDIT UPDATE Lower middle market focused BDC Monroe Capital Corporation (MRCC) ended the IIIQ 2016 with 6 of its 66 portfolio companies under-performing to varying degrees. In aggregate, Watch List asset are valued just over $20mn, and are equally divided between the three tiers the BDC Credit Reporter uses to assess risk.  Only 1 Watch List company (TPP Acquisition) is on non-accrual, and tagged as Non-Performing,  and accounts for a third of the total in dollar terms. That's a Great Experiment for MRCC, which intends to bring the company out of bankruptcy, with a new capital structure and potentially,  even more capital. Some portion of the debt currently on non-accrual for 3 quarters may return to paying status. Watch this space. There is one more Category 5 company in the portfolio. The internet publisher Answers Corporation (now known as Multiply) is already not paying its second lien lenders but MRCC's share of a syndicated First Lien loan is still current, but probably for not much longer. Thankfully for MRCC,  the Answers exposure is not a Material Position by our reckoning (i.e. under 1% of Net Asset Value). There are two Category 4 companies in the portfolio. The other two are both long-standing "troubled credits: Fabco Automotive has been valued below par since 2013 and has just  seen its Unitranche loan (which itself was just restructured and re-priced) written down by a record 51%. The investment size is equal to 1.7% of NAV. Shoe company Rocket Dog Brands, in which MRCC has invested senior and subordinated debt and Preferred and common stock, has been on Watch List Status since 2012.  Still,  remaining exposure is only just over $1mn (from $4.5mn at cost) and 0.5% of NAV. For both Fabco and Rocket Brands the credit trend is still down in the IIIQ of 2016. The Category 4 names, though, contribute only a modest amount to MRCC's overall  income. (Nonetheless, we wonder how MRCC can justify booking  about $0.5mn of annual income  on $3.5mn of Rocket Dog investments at cost-all in PIK form- so we'll be asking Investor Relations).  Fabco pays a mixture of cash and PIK. Finally, there are two Category 3 credits: on the Watch List but more likely than not to still meet all obligations in full: BluestemBrands, Inc. and Playtime, LLC. Both have been written down modestly and are very much paying their bills. Nonetheless, we will remain vigilant. Overall, MRCC's credit quality appears to be in good shape by most any standard at the moment, with Watch List assets accounting for just 8% of September 30, 2016  Net Asset Value.   The BDC Credit Reporter, though, worries both about the strategy of doubling down on bankrupt companies by investing even more time and capital therein; and by the possibility that one or two companies are being "kept alive' for long periods by PIK-ing or reducing debt obligations, but do not have business models with a reasonable hope for success, which we shall call "Zombie Companies". Other than those concerns, MRCC's relatively short history as a public company has resulted in a remarkably clean sheet where net investment losses are concerned, with Realized and Unrealized Losses less than 1% of equity capital at par. DIVIDEND SUSTAINABILITY

Posts for Monroe Capital Corporation

California Pizza Kitchen: Reaches Agreement With Lenders

According to multiple reports, California Pizza Kitchen (“CPK”) – in Chapter 11 bankruptcy – has reached an agreement in principle in late September 2020 with its first lien lenders and unsecured creditors. That should shortly allow the restaurant chain – already making operational plans for post-bankruptcy operations – to make an exit shortly from the court’s protection.

With a bit of luck CPK should exit bankruptcy in the IVQ 2020 and we’ll get a clear picture of which of the now 6 BDC lenders involved ended up where. Total outstandings from the BDC lenders is $49.5mn in IIQ 2020, slightly higher than in the IQ 2020. (BTW, Prospect Flexible Income appears to be no longer a lender). We already know, though, that this will prove to have been a misstep for all the BDCs involved.

TooJay’s Management LLC: Exits Chapter 11

Restaurant chain TooJay’s Management LLC is out of bankruptcy protection after seeking Chapter 11 in April in the middle of the pandemic. The company used the bankruptcy process to relinquish several leases and ends up with 21 locations from 30. All are now operating with dine-in capabilities, as well as takeout and delivery. As part of the restructuring, TooJay’s has shed all its debt.

The new owner is Monroe Capital, whose various funds including publicly traded the publicly traded BDC (MRCC) were the prior lenders to the company. As a result, we expect that MRCC’s $4.1mn in 2022 Term debt and Revolver has been converted to equity. No word yet if any new financing will be provided. The BDC continued to carry the debt as performing through the IIQ 2020 because of the existence of plenty of collateral. Should that debt be converted into common stock as the news suggests, the likely loss of investment income will be just over ($0.25mn) a year. The BDC had written down the debt by only (5%-7%) so no material loss in value is expected going forward now that the company’s near term future is known.

Presumably this means MRCC and its parent will be tied to the restaurant operator for some time. If a successful exit ever occurs, MRCC might make back some or all the write-down associated with the restructuring and any income that might be forgone going forward.

We are upgrading TooJay’s from CCR 5 to CCR 3, reflecting the under-leveraged nature of the post-bankruptcy structure but keeping in mind that the business remains in a thin margin, pandemic-sensitive sector. There are more details to learn but at first approach MRCC – and any other Monroe funds involved – appear to have fared well in what could have a liquidation situation.

California Pizza Kitchen: Files Chapter 11

On July 30, 2020 California Pizza Kitchen (aka CPK) filed for Chapter 11, as part of a broad restructuring plan (RSA) agreed with its first lien lenders. As readers will expect by now, the RSA envisages a “debt for equity swap” and additional financing to get the restaurant company through this difficult period, presumably financed by some or all those same lenders that are in the existing financing. CPK hopes to be in and out of bankruptcy in 3 months.

The BDC Credit Reporter has written about the company on three prior occasions. Our most recent contribution followed learning that several BDC lenders had placed their debt outstanding to the business on non accrual, but not all. In any case, bankruptcy has seemed like a forgone conclusion for some time. As a result, the seven BDCs involved (6 of whom are publicly traded) will have to face the consequences of their $48.1mn invested in the debt of CPK.

Common sense suggests the second lien debt holders : Great Elm Corporation (GECC) and Capitala Finance (CPTA) will have to write off the $4.1mn and $4.9mn respectively held. The rest of the debt is in first lien debt (including a tranche held by GECC) and will mostly become non income producing, when swapped for common shares. We expect the BDCs involved will write off 80% or more of their positions, but we’ll gather more details shortly. As usual in these situations, total exposure may increase as some of the lenders fund their share of the additional capital. For the record, the other BDCs involved are Main Street (MAIN); Capital Southwest (CSWC); Monroe Capital (MRCC) and Oaktree Specialty Lending (OCSL) ; as well as non traded TP Flexible Income with a tiny position.

CPK is – arguably an example of a “Second Wave” credit default. Admittedly, the company was already underperforming before Covid-19 but would likely not have had to file Chapter 11 if the virus had not occurred. As recently as the IIQ 2019 GECC – in a case of ill timing – bought into the second lien at a (5%) discount to par. Going forward, a much de-leveraged CPK should have a decent chance of survival, and may even thrive in the long run. This might allow the BDCs involved to recoup some of their capital but it’s going to be a long slog.

Currently, the BDC Reporter has rated CPK CCR 5 – or non performing – which remains unchanged. We’ll re-rate the company when the RSA – or some other outcome – is finalized. By the way, this is the ninth BDC-financed company to file for bankruptcy – all Chapter 11 – in the month of July, keeping up the blistering pace set in June.

BJ Services Company: Files Chapter 11

Reuters reports that oil field services company BJ Services Company has filed for Chapter 11 on July 20, 2020. The company reported assets and liabilities between $500mn and $1.0bn. Right away, management will be seeking to sell core assets – such as its cementing business – to pay down its debts. Not helping the situation for BJ Services is an admitted “cash crunch”.

Four BDCs have $25.3mn in exposure at cost in the company as of March 31, 2020: Crescent Capital (CCAP); Monroe Capital (MRCC); Garrison Capital (GARS) and non-traded Monroe Capital Income Plus. The BDCs were all in the same 2023 first lien term loan, and marked their positions at par or at a discount of only (4%). Given the industry which BJ operates in; the sizeable liabilities and the liquidity crisis, it seems unlikely that the current high valuation can be maintained in bankruptcy. However, we have no clear idea yet how this debt might fare once everything is settled. We can calculate, though, that ($1.8mn) of investment income on an annual basis will be suspended.

The BDC most at risk of loss is CCAP, which owns about half the outstandings and which is involved in a last out arrangement, which should result in a bigger eventual capital loss.

Frankly, the BDC Credit Reporter has been caught flat footed by BJ’s bankruptcy. The company was carried as performing (CCR 2) in our database because of the near-par valuation by all its lenders. In retrospect, the fact that a oil services firm like this one should stumble is no great surprise. In any case, we have leapfrogged the company’s rating down three levels to CCR 5, or non performing. We’ll be reverting with more details on how the bankruptcy might play out for the BDC lenders involved once we learn more about the company’s plans.

As a parting thought, we do wonder why any BDC would lend to an oil services company – even a giant one – given the well known wreckage of so many similar businesses since 2014. This debt was booked in 2019. Perhaps the recovery the BDC lenders will ultimately achieve will prove us wrong but – if past is prologue – expect that losses will be material and for a loan that was priced at a modest LIBOR + 7.00%.

Bluestem Brands: Business Sold Out Of Bankruptcy

After much back and forth Bluestem Brands Inc. has been acquired out of bankruptcy by its lenders – led by Cerberus Capital Management. The centerpiece of the deal ? Forgiveness of $250mn in debt in return for control of the company in a “debt-for-equity” swap. These details are from a Wall Street Journal article on July 7, 2020. Haggling continued till the very end. At first the buying group offered $300mn, then $200mn and finally $250mn, as discussed in prior articles.

For the four BDCs involved with $34.0mn invested at cost – all in debt – this brings the day of resolution and restructuring closer. The BDCs have already written down their pre-petition positions by (31%)-(40%). We estimate that discount will increase to (55%) when all is said and done. The post-petition debt should get repaid in full or rolled into whatever new capital structure the new owners envisage. Expect to see significant realized losses booked in the third quarter 2020, in the order of ($12mn-$15mn).

Unknown – but not unlikely – is that Main Street (MAIN); HMS Capital; Capitala Finance (CPTA) and Monroe Capital (MRCC) will need to advance more capital going forward to give Bluestem a chance at success. Our readers may expect to be reading about the company – maybe under a new name – for some time to come. The good news ? Maybe some portion of the debt will start paying out its lenders again shortly.

However, the chances of a Chapter Twenty Two, i.e the business falling back into bankruptcy again remain high given the difficult market conditions. Also, much depends on how generously the new Cerberus-led group carves out a new capital structure. We’ve seen multiple examples of new, lender-led groups being shy about making the necessary sacrifices in writing off debt and not injecting new capital. Maybe it’s not in the DNA of lenders more intent on getting their money back than ensuring a business thrives. We need to dig deeper and find out what sort of plan Cerberus and its group has in mind.

Bluestem Brands: Stalking Horse Offer Reduced

As we last wrote on March 11, 2024, Bluestem Brands is in Chapter 11. Now we hear from the Wall Street Journal that the “stalking horse” offer by Cerberus and a group of lenders to the company has been reduced from $300mn to $200mn. Further details are as yet unavailable.

The implications for the 4 BDCs with exposure – which has now increased to $34mn as the lenders provide DIP financing which is performing – are not clear. We expect the BDCs are part of the Cerberus headed attempt to undertake a debt for equity swap. Clearly market conditions have deteriorated since the bankruptcy. This might result in each lender getting a bigger equity slice of a smaller pie or cause another buyer to swoop in or delay the exit from Chapter 11, which has the effect of depleting cash resources. (Bankruptcy is a very expensive process, and this one will shortly be entering its fourth month).

The BDCs involved in the original debt have already discounted their loans by (40%) as of March 31, 2020. Given the reduced perceived value of Bluestem, this might result in a yet bigger discount as of the June 30 valuation and a bigger realized loss when this phase is completed. The $6.3mn in DIP financing, though, should continue to be unaffected for the moment. We maintain the company’s CCR 5 rating.

This drop in the value of Bluestem is emblematic of what is likely to happen to recovery values going forward. Before Covid-19 struck, bankrupt companies were – by and large – retaining much of their value given plentiful capital in the market. Now buyers, investors and lenders are all pulling out their forensic microscopes and values are dropping. We’ll be interested to compare the final discount the lenders have to absorb against the March 31 value when this transaction plays out. It will be instructive both about Bluestem Brands and about recovery expectations more generally. The BDC Credit Reporter guesses we could see a substantial further drop. This is what happens in recessions. The days of a V recovery seem far off.

Evergreen Skills Lux: Files Chapter 11

On June 15, 2020 multiple news sources reported that private-equity education company Skillsoft Corp. (aka as Evergreen Skills Lux) filed for Chapter 11 bankruptcy. From the first details we’ve learned, this is a pre-packaged arrangement and the company – which has about $2.0bn in debt – expects to be in and out of bankruptcy court protection in a short time. As is the fashion these days, this is a debt for equity swap which will see $410mn of debt extinguished in return for control of the business. No word on whether a Debtor In Possession financing is involved, only that Skillsoft expects to have $50mn of liquidity available. More details will follow and we’ll circle back if worthwhile.

Under two different borrower names (Skillsoft Corp and Evergreen Skills Lux SARL) there is $50.3mn invested at cost in the company by 5 different BDCs. These are non-traded BDCs Cion Investment, Business Development Corporation of America and HMS Income, and publicly traded Main Street Capital (MAIN) and Monroe Capital (MRCC). [In an earlier version of this article because of a confusion about the company’s multiple names only one BDC was identified and the amount was smaller].

Skillsoft had been underperforming for some time. From the IIQ 2018 the debt had been discounted more than (10%). As early as IVQ 2019 Cion had already placed its second lien position on non accrual. By the latest quarter – March 31 2020 – all the BDCs had their first and second lien loans rated as non performing. This is yet another large cap company whose debt was priced inexpensively (LIBOR + 475 bps) seeing their financial condition deteriorate more quickly than might otherwise have been the case due to Covid-19. We call these companies First Wave credit casualties.

This is the sixth BDC-financed company to file for bankruptcy protection in June and the second on this day.

CSM Bakery: In Forbearance With Lenders

Business and financial conditions have deteriorated fast at CSM Bakery which – according to Moody’s – “produces and distributes bakery ingredients and products for artisan and industrial bakeries, and for in-store and out-of-home markets, mainly in Europe and North America“. Both Moody’s and S&P have downgraded the company’s debt to SD, or “selective default“. Right now, the asset-based lenders to the company have entered into a forbearance agreement, but only till June 11. Moreover, the 2020 and 2021 term loans have been downgraded to CC and C respectively. This does not look good and a default or restructuring seems likely.

This is bad news for the 4 BDCs involved with $17.3mn invested at cost in those term loans, one which is senior secured and the second subordinated/second lien, according to Advantage Data’s records. The BDCs involved (in descending order of debt held) are non-traded FS Investment II; Monroe Capital (MRCC); Portman Ridge (PTMN) and FS-KKR Capital (FSK). PTMN is in both the loans and MRCC in just the subordinated.

At the end of 2019, this debt was performing and valued close to par. As of March 2020, the BDCs valuations had been discounted by as much as (18%) and the subordinated by (22%). (As always, BDC valuations vary). The current market value of these syndicated loans – using AD’s module – are not much worse right now despite the downgrades. Whether that will continue, especially for the more junior debt, if a default/restructuring occures remains to be seen. As is often the case, we are more pessimistic.

The BDC Credit Reporter had downgraded the company to CCR 3 from CCR 2 after the IQ 2020 results but now reduces the rating to CCR 4, as a loss seems very likely. Furthermore, we are adding the company to our Weakest Links list given the proximity of a non accrual and/or bankruptcy, even though interest has been paid currently till now. There’s ($1.2mn) of investment income at risk of interruption very soon and eventual losses that could exceed ($6.5mn) in our ungenerous estimation, or 38% of cost.

CSM is another example of that second wave of BDC portfolio companies affected by the impact of Covid-19. (The first wave were the companies already badly unperforming but still accruing income before the virus struck. many of those companies have since defaulted/filed Chapter 11 or undertaken major out of court restructurings or are close to doing so). Judging by its valuation the company was performing adequately before the crisis but has deteriorated fast. (Moody’s valued the first lien debt Caa1 in mid-2019). In less than 6 months CSM has gone from adequate performance to the edge of bankruptcy.

(Word to the wise, there will most likely also be a third wave of underperforming companies if the economy does not recover – even if not directly in the worst affected industries – as the weight of servicing debt and the difficulty of raising new capital increases. However, that’s an issue for another time).

We expect to be reporting back on CSM very shortly, given the short leash the lenders are giving the company.

California Pizza Kitchen: Second Lien Debt On Non Accrual

We’ve written about California Pizza Kitchen (or “CPK” to the world) on two prior occasions. Most recently, on April 23, 2020 we discussed the restaurant chain’s ambition to restructure its debt as both secular declines in its business which began some time ago and Covid-19 have made business conditions very difficult. Frankly, we were expecting a bankruptcy filing at any moment, but that has not happened. (That does not mean a Chapter 11 filing could not yet occur).

Now that IQ 2020 BDC results have been published we can see how the 6 different BDCs with exposure have valued their loans. We found that CPK’s first and second lien debt has been placed on non accrual by two of the BDCs and not by four others. Apparently, based on comments made by Monroe Capital Corp (MRCC) – which has not chosen to list the debt as non performing – there is a difference of views between the players. Also choosing to leave the debt on accrual is Main Street (MAIN); Great Elm (GECC) and TP Flexible Income. By contrast, CPTA Finance (CPTA) and Oaktree Specialty Lending (OCSL) have their debt positions marked as non-performing.

Total BDC exposure – spread over first and second lien term loans due in 2022- amounts to $43.3mn at cost. The debt is mostly discounted just under (50%) at FMV, but GECC does have a second lien position written down (78%), while CPTA has discounted its own debt in the same loan by (46%)…

The CPK example speaks to a wider phenomenon that’s always underway where BDC valuations are concerned: discrepancies both about what should be treated as a non accrual and fair value marks. However, the Covid-19 crisis has frequently accentuated the variations and over a much wider number of companies due to the greater degree of uncertainty. This makes taking any one valuation or accrual vs non accrual status too seriously until the credit markets settle down. That could take several quarters as the ratings groups are projecting credit troubles continuing at a heightened level through to 2021.

For our part, we have downgraded CPK from CCR 4 to CCR 5. (We tend to take the most conservative credit position). The company has been removed from the Weakest Links list of companies expected to default given that – as least in two cases – that has already happened. We still believe the chances of a bankruptcy filing are high given that full service restaurants will be challenged for some time and take-out cannot fully make up for business lost.

Update 6/2/2020: CSWC reported IQ 2020 results and placed CPK on non accrual but indicated on the conference call being impressed by management and multiple sources of income to mitigate Covid-19 impact.

TooJay’s Mgmt LLC: Files Chapter 11

A South Florida restaurant chain – TooJay’s Deli LLC – has filed for Chapter 11. Not surprisingly, the principal reason given is the Covid-19 crisis and the impact of the stay at home orders on business. The company “reported assets between $50 million and $100 million and liabilities ranging from $10 million to $50 million. An affiliated company, TJ Acquisition LLC, is also filing for Chapter 11 bankruptcy“.

The only BDC lender to the company is Monroe Capital (MRCC) which has multiple loan facilities with a cost of $4.1mn to the parent (“TooJay’s Mgmt LLC” ), as of 12/31/2019. That debt was all valued at par. There’s $0.300mn of annual investment income that will no longer be coming in.

It’s too soon to determine what capital loss – if any – MRCC might endure because of the bankruptcy. We’ll learn more – presumably – when the BDC reports its results in May. In any case, this is a minor investment and will only have a modest impact – win, lose or draw- on MRCC’s balance sheet and income statement.

More disturbing is that the TooJay’s story presages what might happen much more frequently, and with a great deal more dollars involved: companies that were previously blameless and performing well suddenly filing for bankruptcy. We cannot do much more than bring these sudden credit disasters to your attention once they have occurred as we do not have the data to pick up the signs of distress early as is usually the case.

California Pizza Kitchen: Seeks To Restructure Debt

When we last wrote about California Pizza Kitchen (“CPK”) in December of last year, we said the following about the company and the sector in which it operates: “We will say that we’ve been concerned about negative trends in the restaurant sector since late 2018. We’re not yet at the “apocalypse” phase attached to anything in the retail sector, but there are several secular trends …that even the best and the brightest restaurant chains are having trouble working through. When you’ve got debt to EBITDA levels of 7x or more – as is the case with CPK and many others – the room for maneuver before a restructuring becomes necessary is limited“. We rated CPK a Corporate Credit Rating of 3.

Of course, in the interim we have moved into an “apocalypse” phase for eateries. Not surprisingly, an already weakened and highly leveraged CPK is not faring well. According to the Wall Street Journal on April 23, 2020 , the company has hired restructuring firm Alvarez & Marsal Holdings LLC, along with Guggenheim Partners, to facilitate deal talks with its lender. On the other side the lenders have hired FTI Consulting Inc. and Gibson, Dunn & Crutcher LLP to represent them legally. Now we know – at least – that big fees are going to get paid out by the company…

The situation is very serious, with the two Term loans in which $48.2mn of BDC exposure is invested – one maturing in 2022 and the other in 2023 – are trading in the syndicated markets at discounts of (65%) and (85%) respectively. Not to beat about the bush, we project that a drastic restructuring or a Chapter 11 filing is imminent. We are downgrading CPK to a CCR 4 rating and adding them to our Weakest Link list of companies we expect to shortly move to non accrual.

For the 6 BDCs involved that will mean – if not already happening – an interruption of over $4mn of annual investment income and potential realized losses of ($30mn-$40mn). Unfortunately, the challenges facing eat-in restaurants are not going away any time soon and the delivery business cannot make up for the switch up in how customers feed themselves.

The biggest BDC exposure in dollar terms is that of Main Street Capital (MAIN), with $14mn in the first lien 2022 Term Loan. Capital Southwest (CSWC) and Monroe Capital (MRCC) are also holders of the 2022 loan. However, likely to take it most on the chin from a write-off standpoint are Capitala Finance (CPTA) with $4.9mn invested at cost and Great Elm Corporation (GECC) ($4.0mn) , which are both in the 2023 second lien debt. If past is prolog, the chances are high a complete write-off is in the cards for the 2023 Term Loan holders. (GECC also holds a position in the first lien). We expect some sort of debt for equity swap will be the ultimate resolution as CPK continues to have a viable – albeit shrunken business model. We’re getting ahead of ourselves, though, and will wait to hear how the dueling advisers hash out a plan for the restaurant chain.

Bluestem Brands : Files Chapter 11

After many quarters of balancing on the brink, Bluestem Brands Inc. has filed for Chapter 11. In a press release, the retailer indicated its commitment to remaining in business through the bankruptcy process, and the arrangement of a $125mn DIP financing by a “syndicate of lenders”. The “syndicate” is also serving as a “stalking horse bidder” for the company’s assets, and seeks to de-leverage and restructure the company’s balance sheet.  

Who are the members of the syndicate ? Not disclosed. What might the assets be valued at ? Not mentioned ? How much debt might be wiped from the balance sheet ? Still to be determined. Nonetheless, this seems to be a classic debt-for-equity swap where the lenders become part, majority or the exclusive owners of the new Bluestem Brands. Sometimes that works, and sometimes not.

We’ve been writing about Bluestem Brands for a very long time, both in the BDC Credit Reporter and in our database of all under performing BDC companies that we maintain. Barely a week ago we wrote to ourselves the following summation of our views:”3/4/2020: We worry that Bluestem might be about to meet its moment of reckoning in 2020 with the need to repay its publicly traded Term Loan in November 2020 and its modest liquidity above the mandated level at the end of the IIQ 2019. Sales and EBITDA trends are either anemic or negative. The debt is already discounted by nearly a quarter. As a result, we’ve added the company to the 2020 At Risk Of Non Accrual  list.”  

Now that’s happened we’ll be interested to see what the 4 BDCs with $28.2mn of exposure at cost  – Main Street (MAIN); Capitala Finance (CPTA); Monroe Capital (MRCC) and non-listed HMS Income – will be doing. We imagine they are committed to a portion of the DIP financing and are likely to end up as owners, and may also be committing more junior capital. As mentioned above, we don’t know how much historical debt will be forgiven. So any sort of valuation is hard , but Advantage Data shows the 2020 Term debt in which all the BDCs are invested trading at a (29%) discount; just slightly worse than the recently announced IVQ 2019 (25%) discount announced by the three public BDCs. That suggests, but does not guarantee, the eventual realized loss to be taken might be over ($8mn). In an earlier article, though, we’d been estimating ($15mn). More immediately, income forgone will be about ($1.4mn) annually, mostly absorbed (4/5ths) by sister BDCs: MAIN and HMS Income

We will report back as we learn more about how this bankruptcy will play out, and what individual BDC exposures to old and new capital (if any) will look like. 

Bluestem Brands: Drops Rating and Downgraded

Just in case you didn’t know, it’s the companies themselves who pay for their credit ratings from groups like Moody’s and S&P. (That’s different than at the BDC Credit Reporter, whom nobody pays). We were reminded of this economic fact of life on hearing that Moody’s has “withdrawn’ the ratings of retailer Bluestem Brands. The rating firm – usually prone to long discussions in its regular credit reports – was succinct on this occasion: “Moody’s has decided to withdraw the ratings because of inadequate information to monitor the ratings due to the issuer’s decision to cease participation in the rating process“. No other explanation was given.

Apparently S&P Global has not been any kind of succor. That rating group downgraded the company on January 28, 2020 to CCC- from CCC..Here’s the crux of the matter as S&P sees it: “

Bluestem’s revolver and term loan are due this year and we believe the likelihood that the company will undertake a restructuring in the near term has increased.  The company’s $200 million asset-based lending (ABL) facility matures in July and its term loan (roughly $400 million outstanding) comes due on Nov. 7, 2020. In our view, Bluestem does not have a clear refinancing plan and we believe it is increasingly likely that the company will pursue a holistic debt restructuring to address its maturities given its weak operating performance. If the company pursues a restructuring or exchange that provides its lenders with less than they were originally promised under the security, we would view it as distressed and tantamount to a default”.

We’ve written on three earlier occasions about Bluestem, starting back in the spring of 2019. As far back as June 2019, we had a Corporate Credit Rating of 4 on the company – on our five point scale. More recently, when we began projecting out which BDC-financed under-performing companies were most likely to default in 2020, Bluestem was one of our first additions. Now there seems to be a consensus building that the company will not be able to avoid either a “distressed debt exchange” or a Chapter 11 filing in the months ahead.

For the 4 BDCs involved – all in the 2020 Term Loan, which is structurally subordinated to the Revolver (as far as we can tell) – that’s bad news. Not helping is that S&P is only projecting a 45% recovery rate in event of default. That implies ultimate losses of over ($15mn) over cost, or about ($6mn) more than already provided for at September 30, 2019. Then there’s the $2.7mn of annual investment income at risk of interruption…

We expect to be revisiting Bluestem – and its intractable balance sheet inside a retail sector in seemingly permanent crisis – before long.

The Worth Collection: Liquidating ?

According to a trade publication, The Worth Collection may be in the process of “winding down”. The women’s apparel company’s website is no longer operational according to the report, which checks out. Apparently, there has been a broad campaign to raise additional capital or find a buyer but with no success. The company is owned by PE firm New Water Capital following a purchase in 2016.

Publicly available information is sparse at this point, as much of the pertinent information is behind a paywall. However, we did already know that the company’s debt was placed on non accrual in the IIIQ 2019 by its only BDC lender Monroe Capital (MRCC), which wrote the 2021 Term Loan down (34%). As of now that same debt is trading at a (36%) discount according to Advantage Data’s Syndicated Loans records. The exposure was first initiated in 2016, presumably in conjunction with the New Water acquisition.

This is setting up to be a material reverse for MRCC, which is already missing out on over $1.0mn in annual investment income. The BDC may have to write off anywhere from a third to all of its $10.4mn investment. There may be some value in the brand or other assets, but maybe not. We expect to hear something more official shortly.

California Pizza Kitchen: Downgraded by Rating Groups

We pride ourselves on being timely about alerting readers to material new developments at under-performing BDC-financed companies. In this case, though, we’ve been slow to notice the deterioration underway at iconic restaurant chain California Pizza Kitchen (CPK). In July and August 2019, the company was downgraded by both S&P and Moody’s to speculative grade status. Here’s a sample of what the former said: “We are downgrading CPK to ‘CCC+’ from ‘B-‘ to reflect our view that the company’s capital structure may be unsustainable over the long term.

Moody’s said the following: “CPK’s Caa1 Corporate Family Rating is constrained by its high leverage, modest interest coverage, small scale and geographic concentration relative to comparable casual dining concepts. The company is further constrained by the challenging operating environment which includes soft same store sales growth, with weak traffic trends, and increased labor expense as a percentage of restaurant sales which continue to pressure profitability margins“.

All the above notwithstanding, the 2022 and 2023 Term debt in which seven BDCs have committed $48mn was still valued at a discount of less than (10%) last time results were published in September 2019. As of June 2019 the debt was trading (almost) at par. As of now, though, the publicly traded 2022 Term Loan is trading at a (12.5%-15%) discount, and the more junior 2023 facility at (20%) off. Time to get worried about the $5.0mn of annual investment income that is being generated for the BDCs involved.

There are 6 public BDCs with material exposure, led by Main Street (MAIN) and followed in descending dollar amount by Great Elm (GECC); Monroe Capital (MRCC); Capitala Finance (CPTA); Capital Southwest (CSWC) and Oaktree Specialty (OCSL) – a veritable potpourri of funds with little else in common. There does not seem to be any immediate risk of default, although Moody’s did suggest there was a potential need for a covenant waiver or amendment at year end. That may not have been required or has been granted or could be under discussion. We have a Corporate Credit Rating of 3 on CPK on our 5 point scale, but that could move down quickly in 2020 if performance does not turn around – which seems unlikely – or if PE owner Golden Gate Capital, which bought the famous chain in 2011, does not inject new capital.

We admit the BDC Credit Reporter has been a bit slow to flagging CPK’s credit troubles, but expect to hear much more from us in the months ahead if the company’s debt continues to drop in value. We will say that we’ve been concerned about negative trends in the restaurant sector since late 2018. We’re not yet at the “apocalypse” phase attached to anything in the retail sector, but there are several secular trends – referred to by Moody’s above – that even the best and the brightest restaurant chains are having trouble working through. When you’ve got debt to EBITDA levels of 7x or more – as is the case with CPK and many others – the room for maneuver before a restructuring becomes necessary is limited.

Education Corporation Of America: Involuntary Bankruptcy Filed

For five consecutive quarters Monroe Capital (MRCC) has carried its loan to Education Corporation Of America (ECA) as non-performing. Finally, the BDC – and other creditors – has asked the court to force the for-profit education company into involuntary bankruptcy in Delaware. This is one more step in the slow unwinding of the company. In December of 2018, ECA lost its accreditation and closed campuses all around the country. Subsequently, MRCC bought one of its schools – the New England College of Business – back in May 2019. On MRCC’s books this is now carried as a separate portfolio company. The BDC has $2.2mn in first lien debt and equity invested in the newly acquired education firm which we’ve rated CCR 4. In the IIIQ 2019, the equity value of the MRCC position dropped to $1.1mn from $2.6mn in the prior – inaugural – quarter. That’s not a good sign and given the BDC’s mixed history in this space and the challenges the for profit segment faces, we added New England College to the under performers list.

Back to ECA. That company has been managed by a court appointed receiver for months. Now, for reasons that are not yet clear to us, MRCC and other creditors want a final resolution of this situation. The BDC has $8.2mn at cost invested in ECA, in the form of debt and preferred. Mostly the latter. Interestingly, the BDC still valued its investment at just under $6mn as of September 2019. The creditors may believe there is still some value tied up in the business that might be unlocked by a bankruptcy process.

If the court does accede to the request, the fate of MRCC’s investment in ECA should be known soon. How the New England College Of Business spin-off plays out may take longer to clarify. In any case, this has been a tiresome episode for the BDC, which became involved with ECA and the for profit education sector back in 2015., and which went sideways in a hurry. As recently as March 2018 the investment was valued at par, as Advantage Data’s records show. We added ECA to the under performers list only in the IIQ 2018 and because the preferred was written down a modest (12%). The next quarter ECA was on non accrual. MRCC will likely have to book an eventual Realized Loss of anywhere from ($3mn) to ($8mn). We will undertake a fuller post mortem of the ECA investment in the future once the matter is closed out.

HFZ Capital: Director Of Development Fired For Alleged Mob Ties

This is where the BDC Credit Reporter meets the Sopranos: On December 9, 2019 we hear from multiple news outlets – who love this sort of material – that the Director of Development at real estate company HFZ Capital has been fired. Apparently, the individual in question has been charged by prosectors with working with organized crime to siphon off hundreds of thousands of dollars from New York real estate projects in which HFZ was involved. We should note that the Director Of Development has pleaded not guilty.

This is what the company had to say about the episode: “In a statement, HFZ said it, along with other developers in NYC, learned of the investigation into CWC months ago and removed CWC from its projects. “HFZ immediately terminated Mr. Simonlacaj’s employment upon learning of the allegations against him, which run contrary to the values of the firm and how its business is conducted,” HFZ said.”

More disturbing from a credit standpoint is that this individual had been convicted of an earlier offense and spent 3 months in prison and been vouched for by one of the owners of HFZ as recently as 2016…

The only BDC with exposure to closely held HFZ is Monroe Capital (MRCC) which had two term loans outstanding – due in 2019 and 2021 respectively – with a cost of $23.2mn at September 30, 2019. At the time, the loans were carried at par. However, both loans appear to be publicly traded according to Advantage Data records. The 2019 loan has already reached its maturity and has – presumably – been repaid. However, the 2021 loan was last priced at a (44%) discount to par. MRCC has $5.1mn invested at cost in debt with a face value of $9.0mn.

This is the first time we’ve familiarized ourselves with HFZ Capital – a well known developer in New York who’s seeking to build a huge project in the High Line funded by a hedge fund – and there’s much more to learn. Right away, though, we are giving the company a Credit Rating of 4 – our Worry List – due to the very serious charges brought against one of its top executives and the valuation of the 2021 debt.

Bluestem Brands: Reports Weaker IIQ 2019 Results

We’ve written about Bluestem Brands before on two occasions, on April 12, 2019 and June 19, 2019. Now the multi-name retailer – whose results are publicly made available every quarter – has just completed its IIQ 2019 results. Unfortunately, the turnaround at Bluestem continues, and there are signs that the situation is getting a little worse. We won’t undertake an in-depth diagnosis, although we’ve reviewed both the earnings press release and the Conference Call transcript.

We’ll focus on a key metric – and one of two material debt covenants. Required minimum liquidity – demanded by the senior lenders – is $40mn. This quarter, Bluestem had $50mn, down from $59mn the prior quarter. That’s pretty close, and principally why we’re writing this update.

We have a Corporate Credit Watch of 4 (Worry List) for the company, which has been “troubled” since 2016. The latest results don’t change our rating, but we continue to worry that the company is just one reverse away from a covenant default. That would not be the end of the world, but might suggest the attempt to turnaround the business with its current capital structure is unfeasible. That might involve some debt haircut in some form. Given BDC exposure of $29mn – already discounted – by (23%) by 3 of the 4 BDCs, there could be some further Unrealized Losses to come in the short term.

(We should point out that – for reasons unknown – Capitala Finance (CPTA has only a (4%) discount on its share of the 2020 senior debt, one sixth of what Main Street Capital (MAIN), HMS Income and Monroe Capital (MRCC) have valued the same exposure. There’s been a deviation between CPTA and the other BDCs for several quarters, and we don’t know why. If matters do get worse, CPTA – with $3.7mn of debt at cost – has the farthest to fall).

Bluestem Brands: Reports Latest Results

On June 18, 2019 multi-unit retailer Bluestem Brands reported results for the quarter ended May 3, 2019. We reviewed the earnings press release, and the Conference Call transcript on Sentieo (not yet linkable).  Notwithstanding lower sales in the period compared to a year earlier, the company reported progress in “turning around” the business in several areas. Adjusted EBITDA was barely positive but that’s an improvement over ($12.6mn) a year earlier. Most importantly, from a credit standpoint the company was nowhere near triggering the several key metrics imposed by its senior lenders. Nonetheless, the burden of total debt has remained unchanged over the past several quarters, and its principal Term debt becomes due in late 2020. We have a CCR 4 Credit Rating, which remains unchanged. There are 4 BDCs with $29mn in exposure – all in the 2020 Term debt. In the IQ 2019, the unrealized depreciation was reduced in the BDC valuations and may receive a modest boost in the IIQ, based on these results. Nonetheless, the retailer is far from being out of the woods.

Bluestem Brands: Reports Unaudited Consolidated Fourth Quarter Fiscal 2019 Earnings Results

The troubled e-commerce retailer published quarterly and annual results for the period ended February 1 and 2, 2019.  Despite closing down several brands and taking one-time losses, the Company’s Adjusted EBITDA and key bank covenants, as well as liquidity, all appear better. May stop the gradual erosion in BDC debt values underway since late 2016, which peaked in IVQ 2018. We updated the Company file and the BDC Credit Reporter’s views accordingly. For all the details, see the Company File.